Economic Agenda

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By Roger Bootle

12:01AM BST 23 Jun 2002

(Filed: 23/06/2002)

The ups and downs of retail prices

The inflation figures published last week may have shown the rate plunging to the joint lowest on record but, as I know from my postbag, many readers will feel that this does not gel with their own experiences.

Is this another case of the official statistics being seriously awry?

Swings and roundabouts

In fact, the true rate of inflation is probably lower than the official figures suggest. Indeed, an alternative inflation measure, known as the harmonised index of consumer prices (HICP), shows the annual inflation rate now at 0.8 per cent, compared with 1.8 per cent for the underlying retail prices index (RPI) rate.

I think the HICP measure is probably more accurate. Moreover, because the statisticians fail to take adequate account of improvements in the quality of goods, the true rate of inflation is probably lower still. It is now fair to say that there is next to no inflation in the UK.

So why is this not what people think is happening? Even though inflation overall is very low, there are still many individual prices that are rising sharply. It is easy to give undue weight to them. Moreover, for some people who consume large amounts of the things which are rising markedly in price, their own inflation rate will be higher.

But there is a systematic pattern to the distribution of high and low inflation rates. In general, the rapid price risers are services and the substantial price fallers are goods. In the latest inflation figures the price of services rose by 4.5 per cent whereas the price of goods fell by 0.9 per cent.

Our chart shows the ranking of annual rates of price increase by sector. Top of the group comes so-called leisure services with an inflation rate of over 8 per cent.

This includes the cost of "television licences and rentals", entertainment, foreign holidays and UK holidays, whose prices rose by 18 per cent, 4 per cent, 8 per cent and 5 per cent respectively.

Right at the other end of the spectrum comes clothing and footwear, whose prices fell over the year by almost 5 per cent. Indeed, the statisticians tell us that the prices of what they call "women's outerwear" fell by 9 per cent.

Leisure goods were another spectacular faller - down by almost 4 per cent. And within this category, the price of audio-visual equipment fell by 11 per cent. The category known as motoring expenditure includes a clear illustration of my theme. The price of cars fell by 1 per cent, but the price of car maintenance rose by 5 per cent.

Meanwhile, household goods rose by only 0.7 per cent, whereas household services rose by 4.6 per cent. And although the price of food bought in the shops fell slightly, the price of catering services, which includes takeaways and meals in restaurants and canteens, increased by almost 4 per cent.

Productivity and prices

Prices in the shops have been kept down by rampant competition, which is partly due to the increased provision of retail space by the big store groups and, at the margin, by competition from online shopping.

Yet weaker goods inflation has tended to be the pattern for many years now. Only in 1995/6 did the inflation rate of goods sold in the shops exceed the inflation rate for services. This suggests that there is a systematic factor at work.

In general, productivity rises faster in the production of goods than in the delivery of services. Think of a restaurant meal or a haircut, for instance. There is not a great deal that can be done to raise the productivity of workers engaged in providing these services.

Yet in the manufacture of a car or a television the use of extra capital equipment and new techniques can raise productivity significantly year after year.

However, the pay of service sector workers will have to keep pace in broad terms with that of workers employed in manufacturing. This implies that the price of services will have to go up faster than the price of goods.

Furthermore, over recent decades there has been a continuing tendency to source things more cheaply from abroad. Again, this has been weighted towards the sourcing of goods rather than services.

True, there have been a number of business services which have been successfully sourced abroad, such as airline ticketing or insurance claim processing, but there is less scope for this with consumer services because most of them involve face-to-face contact. A trip to Bangalore for a haircut is not really feasible.

In recent years, the strength of the pound has also exerted downward pressure on the price of goods. But sterling has started to fall as the euro has strengthened.

If this move were to continue at a decent pace then the rate of inflation for goods could again exceed that for services. But, as in 1995/6, this would not last long.

When it pays to wait

What are the consequences of the divergence between the inflation rates for goods and services? It may pay shoppers to hold off from buying goods as they might buy them more cheaply in a year's time.

But there are limits to how far you can take this. It can hardly apply to food, and only marginally to clothes. It does apply to audio-visual equipment, but the trouble is that in a year's time the deflationary pressures may still be in. You could wait forever to buy that CD player at the cheapest price.

For most services, the opposite logic applies. Rising prices mean that it is better to buy now rather than later. But imagine going out for next year's birthday celebrations now in order to save the extra 5 per cent you will be paying next year. And having an extra haircut now to save money later doesn't exactly work either.

The major impact of price divergence will be on our perceptions of value. For anyone brought up with the endemic shortages of the post-war years the falling relative price of things must be quite shocking.

It may seem incredible to the older generation that the cost of a decent restaurant meal for two should cover the whole weekly supermarket food bill, and even more so that this will now be enough to buy a new television.

But changes of a similar magnitude are due to challenge us over the decades to come. Within 20 years, for instance, the cost of a good new saloon car may be lower than the price of a moderate family holiday in the sun.

Yet for most of us, there is no need to fret. These changes are the result of increases in productivity which make our society richer - and which will enable us to afford the apparently ridiculously high prices for restaurant meals and holidays.